What is a Corporation?
A corporation is a separate and distinct legal entity. This means that a corporation can open a bank account, own property and do business, all under its own name. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not personally liable for the debts and liabilities of the corporation. For example, if a corporation gets sued and is forced into bankruptcy, the owners will not be required to pay the debt with their own money. If the assets of the corporation are not enough to cover the debts, the creditors cannot go after the stockholders, directors or officers of the corporation to recover any shortfall.
A corporation is managed by a board of directors, which is responsible for making major business decisions and overseeing the general affairs of the corporation. Like representatives in Congress, directors are elected by the stockholders of the corporation. Officers, who run the day-to-day operations of the corporation, are appointed by the directors.
One major disadvantage of a traditional corporation is double taxation. A traditional corporation, known as a C-corporation, pays a corporate tax on its corporate income (the first tax). Then, when the C-corporation distributes profits to its stockholders, the stockholders pay income tax on those dividends (the second tax). Therefore, tax is paid twice on the same income.
To avoid double taxation, corporations can make a special S-election to be taxed only once on the shareholders personal tax returns. Corporations that make this tax election are known as S-corporations. Why wouldn't every corporation make this valuable election? Not every corporation can qualify.
There are benefits to structuring as a C Corporation but one drawback is that the business is taxed on profits at two different points (double taxation). First when the profits are earned and again when the money is distributed to shareholders as dividends. One positive feature is that the owners are not held personally liable for the financial obligations of the business.
S Corporations are similar to C Corporations in a number of significant ways except that they are only taxed on the profits once. The company itself does not pay taxes but the income from the company is passed through to shareholders and they are required to report any income from the business on their own personal tax returns.
Limited Liability Company - LLC
A Limited Liability Company or LLC is a legal entity that allows you to protect your personal assets from the company’s liabilities. If your business is structured this way the "members" or owners will have no personal responsibility for the financial obligations of the business. With an LLC the business itself does not report taxes on its profits but uses "pass-through" taxation where the income and deductions are reported on the personal income tax returns of the members.
Call us at (401) 884-1950 to help you determine the best structure for your business.
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